Renewable energy sources such as wind and solar power appear to be the impetus behind a South Australian proposal to substantially drop electricity prices, just as other states are hiking theirs.

The Essential Service Commission of South Australian (ESCOSA), which regulates retail electricity prices, has released a draft price determination that proposes an 8.1% reduction in the electricity standing offer, (that is, the default retail price that must be offered to South Australians, at a minimum).

The proposal, which follows an ESCOSA investigation into the wholesale energy costs, translates to a reduction of $27.19/MWh, potentially lowering South Australian electricity bills by an average of $160 per household.

And while it is not specifically acknowledged in the determination, this may be the first time the “merit order effect” of renewable energy sources can conclusively be seen flowing through to consumers in Australia.

The Merit Order Effect

There is nothing special about the “merit order effect”. Quite simply, if you introduce more of a product into a market (that is, increase supply) then prices fall.

The introduction of new capacity upsets the prevailing merit order (the order in which electricity is dispatched, from lowest to highest cost) lowering market prices.

Historically this has been observed when new coal power plants have been added to the market. But the Renewable Energy Target (RET) and other schemes such as the state based feed-in tariffs, are introducing more renewable electricity (supply) to the national electricity market.

Renewables typically have no fuel costs (free sun and wind), and thus have the lowest short run marginal cost of production. This ensures they are lower in the merit order and dispatched prior to anything else in the market. Like a new coal plant, this additional (and low marginal cost) supply also lowers wholesale prices.

This merit order effect has been well documented internationally, and is now widely recognised in South Australia, which has both the highest installed capacity of wind (1203 MW) in Australia, and the highest per capita installation of rooftop Photo Voltaic (PV) solar power.

The volume weighted wholesale prices in SA have reduced from $70-$80 /MWh between 2008-10, to around $45 in 2011, in parallel to the installation of wind and solar capacity (and the flat-lining of demand).

The Australian Energy Market Operator (AEMO) has noted that the South Australian wholesale prices are lower than they have been since the start of the national electricity market, and that the wind “tends to depress the South Australian regional prices”.

A UNSW study demonstrated that periods of high wind output are in general associated with lower market prices, and also appear to contribute to extreme negative price events, while the impact of solar power in South Australia is “blindingly obvious”.

While ESCOSA did not explicitly identify renewables or the merit order effect as a cause of the wholesale price reduction in its draft determination, it did note that: “recent developments in the wholesale electricity market suggested that the forward cost of wholesale electricity may be materially lower than the current [wholesale] allowance.”

It is hard to discount the recent and substantial installation of both wind and PV in the South Australian market as a significant contributor to the suggested “recent developments”.

It should be noted that the wholesale spot price is only part of the picture: spot prices do not reflect the overall cost borne by retailers (for example, the cost related to managing risk). ESCOSA noted that the wholesale electricity cost allowance does not and should not reflect the average “spot price” alone.

The true cost of renewables?

Earlier this year The Australian ran a front page article decrying the cost of renewables, and in particular solar, which argued it would add $140 to the household annual power bills in South Australia. (this is a perhaps a misleading suggestion given it represents two and a half years of costs levied in a single year).

The actual cost of the feed-in tariffs and the cost of the RET is substantially less concerning when put in the correct context of the resulting wholesale price reduction.

According to the draft determination, the cost of compliance with the RET scheme (both small and large scale) is $8.56 per MWh. The annual cost of the Feed-in Tariff scheme in SA is approximately $10.93 per MWh (based on the annual cost, not two and half years of costs).

Combined, these costs are a fraction of the proposed reductions in the wholesale component of the bill. That is, the cost of supporting renewables may be completely offset, (even if only a proportion of the wholesale cost reductions are attributed to the renewables).

Referring to the direct costs of renewables, without including secondary effects such as the merit order effect only paints half the picture and presents a deceptive view of overall costs.

Dylan McConnell is a Research Fellow at University of Melbourne. He receives funding from the Australian Energy Market Commission’s Consumer Advocacy Panel